OPEC Production Rises to 31.85 Mbpd

Oil production spiked in April to 91.0 mbpd according to the IEA. That is a whopping 3.9 mbpd over the same period in 2011. Production increases in Iraq, Nigeria, Angola, Kuwait, UAE and Libya accounted for 510,000 bpd. Algeria, Iran and Qatar saw production decline -190,000 bpd. OPEC supply increased sharply to 31.85 mbpd and well over the 30.0 mbpd quota set at the last OPEC meeting. The majority of the increase was covered by Saudi Arabia. Non OPEC supply only increased by +100,000 bpd to 52.9 mbpd in April. U.S. production growth should be 600,000 bpd by year end.

The IEA also said demand is set to rise by 800,000 bpd to average 90.0 mbpd for the full year with the majority of demand growth in emerging economies. Demand growth in Q4 was flat and Q1 was not much better but the IEA sees demand growth accelerating to 1.2 mbpd by year end to push overall demand at the end of 2012 to 90.4 mbpd. OPEC also said last week that demand growth had accelerated over prior quarters.

Demand growth in China has slowed. Import growth in April was at a slightly slower rate than March but any decline in import growth is seen as a preview of coming attractions. On Friday China posted the slowest increase in Industrial Production since April 2009 at +9.3%. Estimates were for +12.3% growth. That is still strong growth for anyone else but for China it represents a slowing economy. On Saturday the Chinese government cut the reserve requirement ratio by 50 basis points. That was the third cut in six months. They did this to try and stimulate growth and prevent any further declines. Analysts believe they will cut twice more before year end.

Crude prices are declining for multiple reasons. The euro is falling and the dollar rising. Crude is denominated in dollars so a stronger dollar makes it cheaper. European economics are worsening and civil unrest due to austerity is breaking out all over Europe. Conditions are likely to decline further in the coming weeks.

The headlines over Iran have faded from view thanks to the austerity riots in Europe and the breakdown of government in multiple European countries. Iran will return to the news when the next meeting with the P5+1 nations on May 23rd does not go well. Each side has already made known its intentions and talking points and neither side is even close to an agreement on those points. This is going to be a major political factor for president Obama. If Iran is not held to account, Obama will be seen as weak and ineffectual in foreign policy. He has had more than three years to force Iran to end enrichment. To his credit he has gotten them to the negotiating table again and they are under a lot of stress because of the sanctions. He can't afford to let them off the hook only six months before the elections. He needs a clear cut victory here. That suggests Iran is not going to find an easy way out and the headlines are going to return.

Saudi Arabia is doing everything in its power to help the U.S. and prevent the six nations from caving into Iran demands because of fuel prices back home. Saudi repeats almost daily that they have 2.5 mbpd of excess capacity and 80 million barrels of oil in storage with a lot of that storage outside the Persian Gulf and not subject to an Iranian blockade.

The Saudi claims plus rising inventory levels around the world has pushed crude prices to critical support. Analysts believe refiners have stockpiled more crude than normal just in case fighting breaks out in the Persian Gulf ahead of the July 1st embargo. Knowing why inventories are high has not removed any pressure on the prices.

The CME raised margin rates on commodity futures as of last Monday. The new margin rates force traders to hold smaller positions. That decreases liquidity and makes prices more volatile. However, the CFTC said over the long run they did not expect it to have much impact on prices because the market was based on supply and demand not speculation. Surprise!

Oil inventories in the USA rose to 379.5 million barrels last week and a multiyear high. Inventories at Cushing Oklahoma rose to 44.1 million and a record high.

All of these factors contribute to oil prices. As we near the start of the U.S. driving season we should see this three month string of inventory increases begin to decline. This could be the week that begins a two month decline in oil inventories as gasoline consumption rises. Last week is typically the seasonal peak for building inventories.

If the seasonal decline does not begin this week the pricing pressures could increase. Traders will begin to wonder if the system is broken or the U.S. consumer is going to stay home this summer.

I am concerned the political instability in Europe will lead to a deeper economic recession and that will eventually lead to lower demand. Obviously perception of that possibility will lead the actual facts and we could be seeing that in action with prices declining for the last two weeks. The more riots and demonstrations on TV the lower expectations will be.

Brace yourself for a possible break below $95 on WTI.

BP Plc (BP) is back. A BP spokesman said last week they have five deepwater rigs in the Gulf of Mexico and expect to have three more by year end. BP also rolled out its 500 ton spill containment system that could be installed at any deepwater spill around the world in ten days or less. The system is designed to operate in water depths over 10,000 feet and will direct oil and gas escaping from the well to pipelines on the surface. BP will have multiples of these "kits" prepositioned around the world at a cost of $50 million each.

Chesapeake Energy (CHK) fell to a new three year low on Friday after they said they may have to postpone some assets sales in order to stay within their existing loan covenants. CHK is trying to sell up to $14 billion in assets to reduce cash flow problems brought on by low gas prices and curtailed production. A few hours later they announced an unsecured emergency loan of $3 billion from Goldman Sachs and Jefferies Group. The company said it would give Chesapeake some breathing room in its asset sales project. Apparently the industry knew how badly they needed the money and the bids for assets were in the distressed range. Fitch Ratings estimated CHK was facing a funding gap as high a $10 billion in 2012 and had forced capex expenditures of up to $23 billion through 2013.